Special Needs Planning: Don’t Get Stuck Giving Unnecessary Money to the State

Special needs planning requires special expertise. I sat down with a new client last week and asked to review her old estate planning documents. Her Will included a special needs trust for her young adult child with autism. The document was prepared by a prestigious firm, so I was shocked to find that the trust was completely wrong. It had been prepared with a payback clause requiring payment to Medicaid for services rendered to her son upon his death. Reimbursement to the state is required for first-party special needs trusts—those funded with assets of the person with a disability. It is not necessary for a third-party trust such as this, funded by a parent or other loved one. One of the biggest benefits of planning ahead and creating a special needs trust for your loved one is to avoid the need for such payback. This client had spent thousands of dollars on estate planning documents that gave away money to the state she could have otherwise passed on to her other children!

This case was especially egregious, but I regularly come across third-party trusts that are not correctly drafted. Often they incorporate strict requirements that are required only for first-party trusts. The state closely regulates first-party special needs trusts, but third-party trusts have much more flexibility. Unfortunately, I often come across third-party trusts that muddy the waters by referencing the federal statute that exempts first-party trusts from being counted for Medicaid purposes, 42 U.S.C. 1396p(d)(4)(A). This is problematic because Medicaid and Social Security caseworkers generally don’t understand the difference between first- and third-party trusts. Having the first-party language just makes it worse and will inevitably lead to the trust being considered a first-party trust. Even worse, because the trust generally will not include each of the many requirements of a first-party trust (such as requiring notice to the state of all expenditures over $5,000), the beneficiary's public benefits may be denied or terminated.

Another common mistake is using a special needs trust when it is not beneficial or when it is inappropriate. Inexperienced attorneys may think every individual with a disability requires a special needs trust. However, unless the beneficiary is, or is likely to be in the future, receive means-tested benefits, they do not need a special needs trust. A fully discretionary trust offers greater flexibility. And, of course, some individuals with disabilities can manage their own assets, including inherited assets.

Attorneys who do not draft special needs trusts regularly do not appreciate how complex the rules for administering the trusts are. Without a solid grasp of public benefits, they will never be able to direct clients on when a distribution is considered income, whether rent should be charged, and how to determine whether the trust should pay for food and shelter for the beneficiary. If you are going to spend your time and money on special needs planning, it is essential to ensure your attorney has specialized knowledge.